Defining Independent Contractor Agreement
An independent contractor agreement is a contract between a person and the employer that provides that the person will not be treated as an employee but will be treated as an independent contractor. In theory, the person will be responsible for paying the federal, state, and local taxes that an employer would otherwise deduct from an employee’s wages.
In many real estate contexts, this could be set forth in a written memorandum that spells out the duties of the person (the independent contractor), the means by which the person is compensated, a joint expectation that the independent contractor will be able to generate income by means other than the employer and that the relationship will be periodic, not perpetual . The agreement might also include general language about the independent contractor paying his or her own taxes and being responsible for all expenses and liabilities. Depending on the employer’s policies, the agreement may also contain specific language relating to benefits and compensation.
The purpose of the agreement is to create a relationship of independence under the law that gives the independent contractor the right to be treated as such.
Legal Basis for Real Estate Brokers
Real estate brokers are, by definition, independent contractors. To qualify as such, there must be evidence of the requisite control or more importantly, the absence of control. A multitude of factors must be considered in determining whether a worker is an independent contractor or employee under federal and state employment laws. If a real estate broker is treated as an employee, all employment taxes and benefits must be provided by the responsible party.
The IRS provides a general 20-factor test to evaluate the degree of control a business may exercise over the professional work being performed by the broker and its performance. State law will have a similar test. In general, when the broker is treated as an independent contractor, the responsibility for employing, paying, directing and terminating the services of the broker rests with the broker. The broker may engage in other employment apart from any employment agreement or contract. Payment for services to be rendered under the contract is normally made at a flat fee, per-transaction basis or commission and the amount of supervision over the method and manner in which the contract services are performed is minimal or not at all. The manner in which the broker might choose to perform the contract services is not subject to control, and the work can be performed on the broker’s premises or off-site. The broker is generally expected to have an investment in the business, use his or her personal service, skills and judgment, pay for any rental space and supply necessary equipment and facilities, and furnish his or her own services and labor. Under an independent contractor agreement, the payment for services is designed to be only a percentage of the commission or flat fee received. When a broker’s commission is transferred to another party, the broker would be required to address this situation in its independent contractor agreement.
Key Terminology Associated with Broker’s Agreements
When you join a real estate firm as an independent contractor, you will enter into a broker agreement. These agreements are essential for understanding your rights and responsibilities as an independent contractor. Most broker agreements spell out in detail specific terms and conditions of the relationship.
Some of the most common key terms and clauses that appear in these agreements include:
Commission Structure: Most broker agreements lay out how commissions are earned and distributed. Under many arrangements, the broker will receive a percentage of each commission check and, in some cases, a flat monthly fee for office expenses. The amount the broker takes from the commission is often related to how much of the work the broker has done for the agent in relation to the sale (i.e., advertising, listing, etc.). Be sure to have a clear understanding of how commissions for sales are disbursed.
Exclusive Representation: Some broker agreements require you to work exclusively with the brokerage firm, while others allow you to work with multiple brokers. Be sure to understand whether the agreement allows you to maintain working relationships with other brokers.
Responsibility to Pay: The terms of the broker agreement will likely spell out who is responsible for paying the costs of the office (e.g., rent, utilities, office supplies, marketing, etc.). If this is part of the arrangement, be sure to understand exactly what costs you will be expected to pay.
Termination Clause: In the provision of the broker agreement that discusses termination, you should know how much advance notice you are required to give if you plan to end the arrangement, as well as if there is any notice period required before the contract will be terminated by the broker. It is also important to know if there are any restrictions after termination such as non-solicitation of clients or non-compete clauses.
The Pros and Cons
There are advantages and disadvantages for brokers, and also for firms that operate on an independent contractor basis. For the broker in a nominally independent contractor situation, his or her motivation is clear. The desire is to be treated as an independent contractor, not an employee. The broker often sees the benefits that accrue to the firm and other employees from the employee status, and seeks to share in the fruits of the independent contractor designation. He or she may have been told that the independent contractor status allows them to run their own business and will provide them with all the benefits of being a business owner. Others, however, may have had that promise broken, or may come to the conclusion at some point that it is illusory — they will never really be independent and will never really be able to take advantage of the independence of being an independent contractor.
For brokers who are actually treated as independent contractors, and for whom the firm allows them to operate as a true independent business person, the benefits are many. These can include substantial tax benefits, including the availability of income tax deductions for business expenses not otherwise available (or available to a lower extent) to an employee. A business owner can write off a portion of their home as an office expense, a portion of their automobile expenses, and other expenses that are not deductible by an employee.
Independent contractors have greater flexibility in deciding where, when, how and what kind of work they will do. They can accept or decline clients, and have complete control over the manner in which they conduct business. Many agents enjoy being able to control their own schedule, and enjoy having maximum flexibility in when, where and how they work . They can also hire other people, and can benefit from their efforts.
While it is important for firms to properly classify brokers, it is also important for brokers to understand that misclassification can have consequences, and can be a double-edged sword. The first negative consequence is at the federal and state income tax levels, where the broker who has been misclassified as an independent contractor can find themselves liable for income and self-employment tax both for the income of the employee, and a penalty in the form of self-employment tax. Another negative consequence for the broker is that it can be extremely embarrasing to have the IRS audit the firm and the broker being forced to explain why he or she was classified as an independent contractor by the firm. Likewise, being classified as an independent contractor can become a negative factor in a pending divorce.
The second category of consequences covers workers compensation. Independent contractors are not covered by the workers compensation statutes, while employees may be entitled to compensation for an on-the-job injury which could be paid on a no-fault basis (although it may be offset by other sources, including health insurance benefits).
The third category of consequences covers unemployment and disability coverage. An independent contractor is not necessarily covered by unemployment and disability coverage. While the state’s unemployment department and its disability departments may decide that coverage exists, even if the relationship is nominally under a contract, the lack of coverage may later create complications for the broker if he or she is laid off or becomes disabled.
Complying with Applicable Law
Compliance and legal issues can be significant when it comes to real estate broker independent contractor agreements and compensation plans. Although the general trend has been towards establishing an independent contractor relationship, that is no substitute for the obligation of making sure that the terms of the plan or agreement are observed. It is not uncommon for brokers to have a practice where they will make some payments to agents and contractors in anticipation of such a payment being reflected in the final payment calculations either to come out to zero or to be somewhat netted against amounts owed by the agent. The problem with this is that one of the first things that the IRS identifies as a problem in the event that an individual is an employee under its test yet has been treated like a contractor, is the making of advance payments. Therefore, it is essential that all advance payments either be avoided or carefully tracked for zero balance reconciliation at the end of the pay period.
It is also essential that whatever plan you choose, and the compensation plan is entirely voluntary, is fully implemented. If the written plan states, for example, that to participate, the individual needs to have an email address and you required an email address on your application, but you end up paying your new sales person by check because the new agent did not provide you with an email address, you may have a liability to the IRS and other Agencies and significant potential liability and costs.
Experience is vitally important. As a result, if you are developing a new plan or change to a plan, you should consult with Legal Counsel experienced in this area to make sure that you have your "i’s" dotted and your "t’s" crossed.
Drafting an Agreement
A. There are several keys to drafting a comprehensive and effective independent contractor agreement that meets both legal requirements and business objectives:
1. Compensation
a. Although the compensation package for your independent contractors is typically set forth in a separate document (the "compensation schedule"), be sure to cross reference such compensation schedule in the independent contractor agreement.
2. Company Policies
a. The independent contractor agreement should cross reference the company’s general polices and procedures (the "policies"). Further, a good agreement should provide that the policies are subject to change as determined by the broker/owner of the firm. However, make sure to consult with a qualified employment attorney when adopting a policy that could arguably affect an independent contractor’s rights.
3. Terminate for Convenience or Cause
a. The agreement must provide for the ability of either the Company or the Contractor to terminate for convenience. This simply means that any party can terminate the contract by giving the other party prior written notice as set forth in the agreement. Note, however, that the proper amount of prior notice will likely depend upon state law, so be sure to check with a qualified attorney before deciding upon the number of days.
b. The agreement should also provide for termination for "cause." Although "cause" is a subjective term, the more essential provisions of the contract should contain a list of reasons that may constitute "cause . " Typically, such provision will cite reasons such as: breach of contract; fraud or deceit; conviction or pleading of a felony; willful misconduct; and material breach of the policies. Phrase the provision so that the Company has broad discretion when determining whether or not an independent contractor has committed "cause."
c. The Independent Contractor Agreement should further provide that the Company shall have no obligation to pay commissions, royalties, etc. following the date of termination.
4. License and Errors and Omissions
a. The independent contractor must have a valid and duly issued license prior to or contemporaneously with execution of the agreement.
b. The agreement should provide that the contractor is solely responsible for any errors or omissions made in the course of the performance of the contract.
5. Relationship of Parties
a. The Independent Contractor Agreement must define the legal relationship between the Company and the Contractor as an independent contractor relationship. Be certain to include "key factors" that prove an independent contractor relationship exists. Some "key factors" include but are not limited to the following: 1) the degree of control and supervision exercised by the broker; 2) whether the contractor’s work is part of the regular business of the broker; 3) the methods employed or reserved by the broker to pay the contractor; 4) the right to terminate the relationship; 5) the nature of the relationship between the parties; and 6) whether the contractor is in a distinct occupation.